Union Budget 2019: It’s time to move towards parity between banks and NBFCs; gold loan should be given priority sector status
By keeping the NBFCs out of the purview of Section 43D, our tax laws are subjecting the NBFCs to discriminatory treatment as compared to other financial institutions.
This tax arbitrage should be done away with by keeping the interest income in the hands of the end user as tax-free
Gold loan is a small ticket and availed by small and marginal borrowers such as small farmers
Removal of the cap on LTV will help improve formalisation of the economy
On 5 July, the Narendra Modi-led government will present the first Union Budget of its second term. This Budget will offer the first statement of intent from the new government on a host of critical issues, such as the stress in the financial sector affecting banks and non-banks alike, farm prices, employment creation, trade wars, protectionism and the like. As always, a balance will have to be maintained between social welfare and fiscal prudence.
Coming to the financial services sector, this is the right time to move towards parity between banks and non-banking finance companies (NBFCs), by aligning income tax regulations with the directives of the regulators. In this direction, we expect the Budget will address the following:
1) Alignment of Income Tax Act with RBI’s regulations: As the Reserve Bank of India (RBI) is looking to harmonise rules for banks and NBFCs, the Income Tax Act continues to follow the old pattern of differentiated treatment for the two, best exemplified in Section 43D of the Income Tax Act 1961,
“….the income by way of interest in relation to such categories of bad or doubtful debts as may be prescribed having regard to the guidelines issued by the RBI in relation to such debts, shall be chargeable to tax in the previous year in which it is credited by the public financial institution or the scheduled bank or the state financial corporation or the state industrial investment corporation to its profit and loss account for that year or, as the case may be, in which it is actually received by that institution or bank or corporation, whichever is earlier.”
This provision in effect means that assesses (scheduled banks, public financial institutions, state financial corporations, state industrial investment corporations and some public companies like housing finance companies) need not pay tax on the interest accrued in bad or doubtful debt till such time the interest is received from the borrower.
By keeping the NBFCs out of the purview of Section 43D, our tax laws are subjecting the NBFCs to discriminatory treatment as compared to other financial institutions. While the banks are offered the benefit of doubtful interest recovery for tax purposes, no such forbearance applies to the NBFCs even when the RBI mandates similar treatment of an asset, irrespective of whether the lender is a bank or an NBFC.
2) Tax on dividend income: Under Section 115BBDA of the Income Tax Act, shareowner returns on equity investments are taxed three times. First, when the shareowner’s profit share (i.e., profit generated by the company) gets taxed as income tax on corporate profit.
Second, when dividend distribution tax is collected for the share of profit being passed on by the company to its shareowners (on which corporate income tax is already paid).
Third, when the dividend (distributed by the company after paying income tax and dividend distribution tax) gets taxed in the hands of the shareowner, whose dividend income exceeds Rs 10 lakh in a year (this provision was introduced in the 2016 Budget).
No other form of capital gets taxed in this manner. It chases away the investments in the economy besides distorting capital allocation. It is counterproductive and needs rectification. At least the government should revert to a pre-2016 position where the dividend income was tax-free for all shareowners.
3) Tax on interest income: The finance minister should also address the current scenario of tax arbitrage. At present, the law offers an unfair tax arbitrage advantage to debt funds of mutual funds and insurance investment schemes wherein investments made through these channels get tax advantage in the form of indexation benefit which is not available for any other investments such as bank deposit, postal saving scheme or debt investment.
This tax arbitrage should be done away with by keeping the interest income in the hands of the end user as tax-free. This relaxation will offer banks and financial institutions leeway to raise deposits at a lower cost and will increase credit offtake to enable faster transmission of policy rate cuts and spur economic growth.
4) Priority sector status for gold loans: Gold loan companies have been the most prominent agents of formalisation in the Indian economy in recent years. These companies have created infrastructure across the country, often at places where banks and other institutions are yet to mark their presence.
As a loan product, a gold loan is not only uncomplicated and transparent, but it often saves the poor from having to take recourse to moneylenders as well. The product is a small ticket and availed by small and marginal borrowers such as small farmers and microenterprises.
When the borrowers are from the priority sector, there is no logic in denying the priority sector status; primarily when the gold loans given to farmers by banks get classified as priority sector lending. In an effort to drive parity between banks and the NBFCs, the finance minister may consider all micro gold loans (i.e. under Rs 50,000) eligible for priority sector lending status. In this context, the finance minister may also consider giving priority sector status for the bank’s lending to the NBFCs for on-lending to priority sector borrowers such as microenterprises or farmers.
5) SARFAESI Act: Talking about parity, the government should also look at creating parity between banks and an NBFC on the mechanisms available to them for recovery of dues.
While the banks are allowed access to Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act (SARFAESI Act) and the debt recovery tribunals (DRTs), an NBFCs can enforce its security interest through SARFAESI only in cases involving the principal amount of at least Rs 1 crore or more whereas the monetary limit prescribed for other classes of secured creditors is Rs 1 lakh.
If the policy objective is to drive credit access and create parity between lenders based on the nature of the business, then, it is only fair that the NBFCs receive similar access to SARFAESI and DRTs for recovering the dues.
6) LTV cap on gold loans: The loan-to-value (LTV) cap on the gold loan is an idea that has survived well beyond its sell-by date. When it was introduced, it was the right solution, but policy-making needs to be dynamic and agile. Currently, an NBFC can lend up to a maximum of 75 percent against the value of gold. On the ground, we now have a situation where this is actually nudging the poor and marginal farmers, micro-entrepreneurs etc. back to the unregulated lenders who offer higher LTV.
Removal of the cap on LTV (balanced by regulations prescribing higher risk-weight for higher LTV loans), will help improve formalisation of the economy, ensure financial stability and most importantly, curb the re-emergence of money lenders who were becoming redundant through years of policy interventions.
(The writer is MD and CEO, Manappuram Finance)
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